Minimum Wages and Job Signalling

The main consistent conclusions of the empirical literature about the effects of minimum wages are threefold. First, there exists evidence about the negative employment effects of minimum wages, notably for the least-skilled groups. Secondly, after an increase in minimum wage, the probability that a teenager leaves school also increases. And, thirdly, the minimum wage affects not only the earnings of workers on minimum wage, but also of other workers with higher wages. In this paper we present an adverse selection model that deals with all these aspects. In this model, costly education serves as a signal of the worker’s ability, which, initially, is private information. The firms in this model make competitive offers to workers after observing if they are or not educated, but retain the option to fire them when their true ability is revealed. Under this model setting, after the establishment of a minimum wage, an adverse selection problem emerges and no low skilled worker is hired. We show how a situation of equilibrium could be re-established through changes in the firing and educational costs that reinforce the signalling mechanism. These changes, however, do not alter, qualitatively, the main conclusions about the effects of minimum wage, since the negative effect on low skilled unemployment, on the spill-over in wages, and on the discouraging effect on education, persist.